Auction theory and Auction theory and policypolicy

1.1. Why auction theory matters for Why auction theory matters for governmentsgovernments

2.2. Europe and the 3G auctions:Europe and the 3G auctions:The UK and the NetherlandsThe UK and the Netherlands

3.3. Auctions and the Victorian Auctions and the Victorian GovernmentGovernment

1: Why auction theory matters for 1: Why auction theory matters for governmentgovernment

Governments:Governments: Buy goods (and services)Buy goods (and services) Sell goodsSell goods

Auctions overcome information Auctions overcome information problems (adverse selection)problems (adverse selection)

Auctions are transparentAuctions are transparent

1: Why auction theory matters for 1: Why auction theory matters for governmentgovernment

Auction design impacts on behaviour, which Auction design impacts on behaviour, which in turn impacts on the outcome of the in turn impacts on the outcome of the auctionauction

Auctions can be tailored to reflect:Auctions can be tailored to reflect:

The government’s objectivesThe government’s objectives The good/service being auctionedThe good/service being auctioned

Single units or bundles of units? Do complementarities exist Single units or bundles of units? Do complementarities exist between units? between units?

The nature of the marketThe nature of the marketCompetitive industry? (Market power a problem?)Competitive industry? (Market power a problem?)Collusion likely to be a problem?Collusion likely to be a problem?

2: Europe and the 3G auctions2: Europe and the 3G auctions

What is a “3G license”?What is a “3G license”?

The policy issue:The policy issue:

In 2000 six Governments across Europe auctioned off 3G In 2000 six Governments across Europe auctioned off 3G licenses.licenses.

3G new technology: governments had no capacity to 3G new technology: governments had no capacity to estimate the value of licenses.estimate the value of licenses.

3G licenses had a “common value” component3G licenses had a “common value” component Each country designed its own auction.Each country designed its own auction. Each market had different market conditions (number and Each market had different market conditions (number and

size of incumbents and potential market entrants).size of incumbents and potential market entrants). Countries made different numbers/bundles of licenses Countries made different numbers/bundles of licenses

available for purchase.available for purchase.

2.1: The UK auctions2.1: The UK auctions

The UK market conditions:The UK market conditions: 4 incumbent companies with market advantages4 incumbent companies with market advantages Several potential market entrantsSeveral potential market entrants

Government goals:Government goals: Assign licenses efficientlyAssign licenses efficiently Encourage competition Encourage competition To “realise the full economic value” of licensesTo “realise the full economic value” of licenses

Limit of one license per bidder (to maintain a competitive Limit of one license per bidder (to maintain a competitive industry)industry)

The Government hired auction theorists to design the auction The Government hired auction theorists to design the auction and tested the design in experimental labs. and tested the design in experimental labs.

2.1: The UK auctions cont…2.1: The UK auctions cont…

The original plan was to sell 4 licenses.The original plan was to sell 4 licenses.

Because there were 4 incumbents there was Because there were 4 incumbents there was concern that an ascending auction (English concern that an ascending auction (English Auction):Auction):

Would discourage new entrants, as dominant Would discourage new entrants, as dominant companies can always out-bid weaker firmscompanies can always out-bid weaker firms

May lead to collusion May lead to collusion

On the other hand there was concern that a sealed-On the other hand there was concern that a sealed-bid auction may lead to an inefficient outcome, as bid auction may lead to an inefficient outcome, as dominant firms may under-bid in an attempt to dominant firms may under-bid in an attempt to capture large surpluses, and therefore be outbid capture large surpluses, and therefore be outbid by weaker firmsby weaker firms

2.1: The UK auctions cont…2.1: The UK auctions cont…

The Government therefore planned to run an The Government therefore planned to run an “Anglo-Dutch” auction: an ascending “Anglo-Dutch” auction: an ascending auction would run until 5 contestants auction would run until 5 contestants remained, at which point these companies remained, at which point these companies would submit sealed bids at or exceeding would submit sealed bids at or exceeding the final price.the final price.

This format performed well in experimental This format performed well in experimental testing.testing.

2.1: The UK auctions cont…2.1: The UK auctions cont…At this point, a fifth license became available for sale. At this point, a fifth license became available for sale.

As a result the government elected to use a simple As a result the government elected to use a simple ascending (English) auction - the restriction of one ascending (English) auction - the restriction of one license per company and the availability of a fifth license per company and the availability of a fifth license made it possible for a new market entrant license made it possible for a new market entrant to purchase a license.to purchase a license.

9 new market entrants participated (+ 4 incumbents)9 new market entrants participated (+ 4 incumbents)

The UK 3G auction raised €39billion The UK 3G auction raised €39billion

This auction format gave the government a good This auction format gave the government a good understanding of the value the market placed on understanding of the value the market placed on 3G licenses.3G licenses.

What can be learned from the UK 3G What can be learned from the UK 3G auction?auction?

There is no such thing as a “good auction,” There is no such thing as a “good auction,” just a “good auction for the particular just a “good auction for the particular task.”task.”

UK Government hired auction theorists and UK Government hired auction theorists and tested their auction design in the lab to tested their auction design in the lab to make sure that their design was robust make sure that their design was robust and achieved their goals.and achieved their goals.

2.1: The UK auctions cont…2.1: The UK auctions cont…

2.2: The Netherlands auctions2.2: The Netherlands auctions

The Dutch market conditions:The Dutch market conditions:5 incumbent companies with market 5 incumbent companies with market

advantages (versus 4 in the UK)advantages (versus 4 in the UK)

5 licenses for purchase (as per the UK)5 licenses for purchase (as per the UK)

The Dutch Government used the same The Dutch Government used the same design as the UK Government – an design as the UK Government – an ascending auction.ascending auction.

2.2: The Netherlands auctions cont...2.2: The Netherlands auctions cont...

Recognising that the 5 incumbent companies would Recognising that the 5 incumbent companies would be able to out-bid them, smaller companies chose be able to out-bid them, smaller companies chose to make deals with the incumbents rather than to make deals with the incumbents rather than losing at auction. losing at auction.

Only 1 non-incumbent participated (+ 5 incumbents)Only 1 non-incumbent participated (+ 5 incumbents)

The Netherlands auction raised €3 billion (versus €39 The Netherlands auction raised €3 billion (versus €39 billion in the UK). billion in the UK).

The auction did not reveal to the Dutch Government The auction did not reveal to the Dutch Government the value the market placed on 3G licenses.the value the market placed on 3G licenses.

2.2: The Netherlands auctions cont...2.2: The Netherlands auctions cont...What can be learned from the Netherlands’ What can be learned from the Netherlands’

3G auction?3G auction?

The auction format that works in one set of The auction format that works in one set of circumstances is extremely unlikely to work circumstances is extremely unlikely to work successfully in other circumstances – subtle successfully in other circumstances – subtle variations in the market conditions can give rise variations in the market conditions can give rise to big differences between outcomes. Treating to big differences between outcomes. Treating auction designs like “blueprints” is extremely auction designs like “blueprints” is extremely risky for governments.risky for governments.

Auctions needs to be tailor-made; auction theory Auctions needs to be tailor-made; auction theory and experimental testing will substantially and experimental testing will substantially improve auction outcomes.improve auction outcomes.

3: Auctions and the Victorian Government3: Auctions and the Victorian Government

BushTender:BushTender:

The Government wanted to improve native vegetation The Government wanted to improve native vegetation on private land – therefore needed to procure on private land – therefore needed to procure improvements in native vegetation.improvements in native vegetation.

The Government wanted to engage private landholders The Government wanted to engage private landholders in contracts to improve their native vegetation.in contracts to improve their native vegetation.

A specific goal was that contracts should be “cost-A specific goal was that contracts should be “cost-effective.”effective.”

3: Auctions and the Victorian Government3: Auctions and the Victorian GovernmentProblems:Problems:1.1. It was difficult to measure “improvements in It was difficult to measure “improvements in

native vegetation” – the good the government native vegetation” – the good the government wanted to purchase was poorly definedwanted to purchase was poorly defined

2.2. It was difficult to identify the landholders who It was difficult to identify the landholders who offered the government good “value for offered the government good “value for money” (adverse selection)money” (adverse selection)

Solution:Solution:1.1. The Government developed a metric that The Government developed a metric that

made it possible to measure the quality and made it possible to measure the quality and quantity of vegetation improvements that they quantity of vegetation improvements that they were purchasing (Habitat Hectare)were purchasing (Habitat Hectare)

2.2. The Government decided to use an auction The Government decided to use an auction mechanism to allocate contracts for mechanism to allocate contracts for improvements in native vegetation.improvements in native vegetation.

3: Auctions and the Victorian Government3: Auctions and the Victorian Government

Design questions:Design questions:

1.1. First price or second price? First price or second price? (Discriminating price or uniform (Discriminating price or uniform price auction)?price auction)?

2.2. Sealed bid or open auction?Sealed bid or open auction?

3.3. Single round or multiple rounds?Single round or multiple rounds?

4.4. How encourage participation?How encourage participation?

3: Auctions and the Victorian Government3: Auctions and the Victorian Government

The piloted BushTender format:The piloted BushTender format: First-price auction (discriminating First-price auction (discriminating

price auction)price auction) Sealed bidSealed bid Single roundSingle round Encouraged participation through Encouraged participation through

lengthy engagement with potential lengthy engagement with potential participants and information participants and information distribution. distribution.

3: Auctions and the Victorian Government3: Auctions and the Victorian Government

3: Auctions and the Victorian Government3: Auctions and the Victorian Government

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Auction theory and policyAuction theory and policySummary:Summary: Auctions are a transparent allocation mechanismAuctions are a transparent allocation mechanism The design of an auction impacts on participants’ The design of an auction impacts on participants’

behaviour (bidding), and in turn the outcome of the behaviour (bidding), and in turn the outcome of the auction auction

Well-designed auctions can be used to:Well-designed auctions can be used to:• Improve allocative efficiency Improve allocative efficiency • Increase revenue / reduce expenditureIncrease revenue / reduce expenditure• Gather informationGather information

Auctions must be carefully designed to reflect policy Auctions must be carefully designed to reflect policy objectives and the specific nature of the good/s being objectives and the specific nature of the good/s being auctioned and market conditionsauctioned and market conditions

Auction theory and can be used to improve auction Auction theory and can be used to improve auction design, while testing in experimental labs can be used design, while testing in experimental labs can be used to test the robustness of an auctionto test the robustness of an auction and to minimise and to minimise the risk of unexpected outcomesthe risk of unexpected outcomes